Foreign direct investment (FDI) is often seen as a powerful engine of economic growth. Yet policymakers are frequently told that attracting FDI is not enough: countries must first build “absorptive capacity” through better education, deeper financial markets, stronger institutions, or greater openness to trade. A new study by Chris Muris and Konstantin M. Wacker puts this widely held belief under the microscope—and the results are surprising.

Using data from around 120 countries over the past five decades, the authors revisit the link between FDI and economic growth with modern panel data methods. What makes their approach distinctive is that it separates policy-relevant changes—things governments can realistically influence—from deeper, time-invariant country characteristics such as geography or long-standing structural features.

The findings challenge much of the conventional policy advice. Most of the differences in how countries benefit from FDI are explained by these time-invariant fundamentals rather than by changes in absorptive capacity. Among the four commonly cited capacities—human capital, financial development, institutional quality, and trade openness—only trade openness shows consistent evidence of strengthening the growth effects of FDI. Even then, the bar is not very high: fewer than 10 percent of countries fall below the level at which FDI appears to support growth.

Perhaps most strikingly, improvements in education, finance, or institutions do not robustly amplify the benefits from FDI and may even weaken them in some cases.

The key takeaway is not that these policy areas are unimportant—but that they may matter less for harnessing FDI than previously thought. For countries hoping to grow through foreign investment, the results suggest a need to rethink the emphasis on broad absorptive-capacity building as a prerequisite for success.

Access the paper: This research is publicly available via the GGDC Research Memorandum Series and the GGDC Dataverse Repository. DOI: 10.34894/XKCMI6